IB Business Management SLTopic 3 — Sources of FinancePaper 1 & 2Core idea~10 min read
Raising Money From Inside the Business
Internal finance is money the business already has: the owner’s savings, profit it kept, or things it can sell. No interest, no forms, no bank manager. The catch is that there is only so much of it, and using it always means giving something up.
📚 What you need to know
Internal finance comes from inside the business. External finance comes from outside.
The three internal sources: owner’s capital (personal savings), retained profit and sale of assets.
Internal finance is usually free of interest and fast to arrange.
No outsider gets a say in decisions, so the owner keeps full control.
Every internal source has an opportunity cost — the money can only be spent once.
Sale and leaseback lets a firm sell a building for cash and then rent it back so it can keep using it.
Internal finance is often not enough for a big project, which is why external sources exist.
The map of all sources
Before the detail, get the shape of the topic in your head. Everything splits into two, and every exam question sits somewhere on this tree.
Draw this tree at the top of a finance answer and you will not forget a source under pressure.
Owner’s capital: personal savings
The owner puts their own money in. It is the usual way a business starts, and owners often add more later — when the firm is growing, or when a short-term cash problem appears. The money might be savings, an inheritance or a redundancy payment.
Good: instant, no interest, no paperwork, and no outsider gains any control.
Bad: it is limited by how much the owner actually has, and if the business fails they lose their own savings. For a sole trader with unlimited liability, that risk goes further than the money invested.
Retained profit
Profit made in earlier years that was not paid out to owners or shareholders, and is put back into the business instead. It is the most common way established firms fund growth.
This fork is the reason “retained profit is free” is only half true. It costs the owners the money they did not receive.
Good: no borrowing, so no interest and no arrangement fees; nobody outside gets a vote; it is available immediately.
Bad: shareholders get less; a start-up has none; and once it is spent it cannot be used for anything else.
Sale of assets
Selling things the business no longer needs — old machinery, a spare vehicle, unused land — turns them into cash. Nothing is borrowed and nothing is repaid.
If the business still needs the asset, it can use sale and leaseback: sell the building to an investor for a large cash sum, then rent it back and carry on trading from it as normal. Big retailers do this with their stores.
Sale and leaseback in one line
Sell the asset now for cash → pay rent on it forever afterwards
Good: raises a lot of cash quickly from something already owned; unused assets stop costing money to store and insure.
Bad: the asset is gone for good; rent becomes a new fixed cost; a rushed sale usually gets a poor price; and you can only sell an asset once.
Internal source
Best for
Main advantage
Main drawback
Owner’s capital
Starting up, small top-ups
Instant and free, no loss of control
Limited amount; owner’s own money at risk
Retained profit
Funding growth in an established firm
No interest and no repayment
Lower dividends; none exists in a start-up
Sale of assets
Raising a lump sum from what is unused
No debt created
One-off only; asset lost; sale price may be low
Examiners are looking for one word here: opportunity cost. Internal finance is never truly free, because that money could have done something else. Say what the something else was.
Worked examples
WORKED EXAMPLE 1
Calculating retained profit [4 marks]
Kestrel Ltd made a profit after tax of $180,000 last year and paid dividends of $65,000. Retained profit brought forward from earlier years was $240,000. Calculate the retained profit for the year and the total now held.
Step 1: retained profit for this year$180,000 − $65,000 = $115,000Step 2: add what was already there$240,000 + $115,000 = $355,000$115,000 this year; $355,000 in totalcareful: the $355,000 is not sitting in a drawer as cash — most of it is already tied up in stock, equipment and money owed by customers
WORKED EXAMPLE 2
Should they sell and lease back? [10 marks]
A family bakery owns its shop, valued at $600,000. It wants $250,000 to open two new branches. An investor offers to buy the shop for $580,000 and rent it back at $42,000 a year. Evaluate this plan.
Step 1: does it solve the problem?$580,000 raised against a $250,000 need. Yes, easily, with no loan and no interest.
Step 2: what does it cost long term?$42,000 a year, forever, as a new fixed cost. Over ten years that is $420,000.
Step 3: what else is lost?
The shop is no longer an asset, so future borrowing has no security behind it, and any rise in property value now belongs to the investor.
Step 4: compare with the alternative
A mortgage of $250,000 keeps the building and costs interest on a much smaller sum.
Raises too much and costs too much: borrow the $250,000 insteadthe judgement turns on the size of the need — sale and leaseback suits a business that needs a very large sum fast, not one needing $250,000
💡 Exam tip
Check the age of the business. A start-up has no retained profit and few assets, so internal finance is nearly always owner’s capital.
Use the phrase no interest and no loss of control — it is the core advantage of every internal source.
Always give the opportunity cost. What is this money no longer available for?
Look for numbers in the stimulus: if the firm needs $2m and holds $300,000 in reserves, internal finance simply is not enough. Say so.
Sale of assets is a one-off. It cannot fund an ongoing cost like wages.
Mention the owner’s personal position: their savings, their attitude to risk, whether they want to stay in charge.
⚠ Common mix-up
Retained profit called cash. It is profit kept in the business, and it may already be spent on stock or machinery.
“Internal finance is free.” Free of interest, not free of opportunity cost.
Share capital treated as internal. Selling shares brings money in from outside investors, so it is external.
Confusing sale of assets with sale and leaseback. In leaseback the firm keeps using the asset and starts paying rent.
Saying a start-up should use retained profit. It has not made any profit yet.
Forgetting unlimited liability. For a sole trader, personal savings are not the limit of the risk.
Up next: Raising Money From Outside the Business — loans, shares, overdrafts and the rest, and what each one really costs you.
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